2. Financial Accounting, Seventh Edition
Chapter 5
Accounting for Merchandising Operations
Financial Accounting, Seventh Edition

3. Study Objectives
Identify the differences between service and merchandising companies.
Explain the recording of purchases under a perpetual inventory system.
Explain the recording of sales revenues under a perpetual inventory system.
Explain the steps in the accounting cycle for a merchandising company.
Distinguish between a multiple-step and a single-step income statement.
Explain the computation and importance of gross profit.

4. Accounting for Merchandising Operations
Recording Purchases of Merchandise
Recording Sales of Merchandise
Completing the Accounting Cycle
Forms of Financial Statements
Operating cycles
Flow of costs—perpetual and periodic inventory systems
Freight costs
Purchase returns and allowances
Purchase discounts
Summary of purchasing transactions
Sales returns and allowances
Sales discounts
Adjusting entries
Closing entries
Summary of merchandising entries
Multiple-step income statement
Single-step income statement
Classified balance sheet

5. Merchandising Operations
Merchandising Companies
Buy and Sell Goods
Wholesaler
Retailer
Consumer
The primary source of revenues is referred to as sales revenue or sales.
SO 1 Identify the differences between service and merchandising companies.

6. Target is a Retailer

7. Merchandising Operations
Income Measurement
Sales
Revenue
Not used in a Service business.
Less
Illustration 5-1
Cost of
Goods Sold
Gross
Profit
Equals
Less
Net
Income
(Loss)
Operating
Expenses
Equals
Cost of goods sold is the total cost of merchandise sold during the period.
SO 1 Identify the differences between service and merchandising companies.

8. Merchandising Operations
Operating Cycle
Illustration 5-2
The operating cycle of a merchandising company ordinarily is longer than that of a service company.
SO 1 Identify the differences between service and merchandising companies.

9. In Chapter 2, we discussed the Historical Cost Principle
Assets are recorded on the Balance Sheet at cost
Cost includes all costs necessary to get the asset ready for its intended purpose
$5,000

10. The Historical Cost Principle also applies to Inventory
Inventory is a Current Asset
It is recorded on the Balance Sheet at Historical Cost
Cost includes all costs necessary to get the inventory ready for its intended purpose
Let’s look at the cost components for Inventory…..

11. Let’s assume a Perpetual Inventory System
A Perpetual Inventory system records all changes in the value of Inventory directly in the Inventory Account.

12. Merchandising Operations
Flow of Costs
Perpetual System
Purchases increase Merchandise Inventory.
Freight costs, Purchase Returns and Allowances and Purchase Discounts are included in Merchandise Inventory.
Cost of Goods Sold is increased and Merchandise Inventory is decreased for each sale.
Physical count done to verify Merchandise Inventory balance.
The perpetual inventory system provides a continuous record of Merchandise Inventory and Cost of Goods Sold.

13. Merchandising Operations
Flow of Costs
Periodic System
Purchases of merchandise increase Purchases.
Ending Inventory determined by physical count.
Calculation of Cost of Goods Sold:
Beginning inventory $ 100,000
Add: Purchases, net 800,000
Goods available for sale 900,000
Less: Ending inventory 125,000
Cost of goods sold $ 775,000
This is similar to the ATM example….

14. Recording Purchases of Merchandise
Illustration 5-5
Made using cash or credit (on account).
Normally recorded when goods are received.
Purchase invoice should support each credit purchase.
SO 2 Explain the recording of purchases under a perpetual inventory system.

15. Recording Purchases of Merchandise
Under the perpetual inventory system, companies record in the Merchandise Inventory account the purchase of goods they intend to sell.
Illustration: From INVOICE NO. 731 (Illustration 5-5) record the journal entry Sauk Stereo would make to record its purchase from PW Audio Supply.
May 4
Merchandise inventory 3,800
Accounts payable 3,800
SO 2 Explain the recording of purchases under a perpetual inventory system.

16. Recording Purchases of Merchandise
Freight Costs – Terms of Sale
Illustration 5-6
Seller places goods Free On Board the carrier, and buyer pays freight costs.
Seller places goods Free On Board to the buyer’s place of business, and seller pays freight costs.
Freight costs incurred by the seller are an operating expense.
SO 2

17. Recording Purchases of Merchandise
Illustration: Assume upon delivery of the goods on May 6, Sauk Stereo pays Acme Freight Company $150 for freight charges, the entry on Sauk Stereo’s books is:
May 6
Merchandise inventory 150
Cash
Assume the freight terms on the invoice in Illustration 5-5 had required PW Audio Supply to pay the freight charges, the entry by PW Audio Supply would have been:
May 6
Freight-out (or Delivery Expense) 150
Cash
SO 2 Explain the recording of purchases under a perpetual inventory system.

18. Recording Purchases of Merchandise
Purchase Returns and Allowances
Purchaser may be dissatisfied because goods are damaged or defective, of inferior quality, or do not meet specifications.
Purchase Return
Purchase Allowance
Return goods for credit if the sale was made on credit, or for a cash refund if the purchase was for cash.
May choose to keep the merchandise if the seller will grant an allowance (deduction) from the purchase price.
SO 2 Explain the recording of purchases under a perpetual inventory system.

19. Recording Purchases of Merchandise
Illustration: Assume that on May 8 Sauk Stereo returned to PW Audio Supply goods costing $300.
May 8
Accounts payable 300
Merchandise inventory 300
SO 2 Explain the recording of purchases under a perpetual inventory system.

20. Recording Purchases of Merchandise
Purchase Discounts
Credit terms may permit buyer to claim a cash discount for prompt payment.
Advantages:
Purchaser saves money.
Seller shortens the operating cycle.
Example: Credit terms of 2/10, n/30, is read “two-ten, net thirty.” 2% cash discount if payment is made within 10 days.
SO 2 Explain the recording of purchases under a perpetual inventory system.

21. Recording Purchases of Merchandise
Purchase Discount Terms
2/10, n/30
1/10 EOM
n/10 EOM
2% discount if paid within 10 days, otherwise net amount due within 30 days.
1% discount if paid within first 10 days of next month.
Net amount due within the first 10 days of the next month.
SO 2 Explain the recording of purchases under a perpetual inventory system.

22. Recording Purchases of Merchandise
Illustration: Assume Sauk Stereo pays the balance due of $3,500 (gross invoice price of $3,800 less purchase returns and allowances of $300) on May 14, the last day of the discount period. Prepare the journal entry Sauk makes to record its May 14 payment.
May 14
Accounts payable 3,500
Cash ,430
Merchandise Inventory 70
(Discount = $3,500 x 2% = $70)
SO 2 Explain the recording of purchases under a perpetual inventory system.

23. Recording Purchases of Merchandise
Illustration: If Sauk Stereo failed to take the discount, and instead made full payment of $3,500 on June 3, the journal entry would be:
June 3
Accounts payable 3,500
Cash 3,500
SO 2 Explain the recording of purchases under a perpetual inventory system.

24. Recording Purchases of Merchandise
Purchase Discounts
Should discounts be taken when offered?
Passing up the discount offered equates to paying an interest rate of 2% on the use of $3,500 for 20 days.
Example: 2% for 20 days = Annual rate of 36.5%
(365/20 = twenty-day periods x 2% = 36.5%)
SO 2 Explain the recording of purchases under a perpetual inventory system.

25. Recording Purchases of Merchandise
Summary of Purchasing Transactions
Illustration
4th - Purchase
$3,800
$300
8th - Return
6th – Freight-in
150 70
14th - Discount
Balance
$3,580
SO 2 Explain the recording of purchases under a perpetual inventory system.

26. Recording Sales of Merchandise
Made for cash or credit (on account).
Normally recorded when earned, usually when goods transfer from seller to buyer.
Sales invoice should support each credit sale.
Illustration 5-5
SO 3 Explain the recording of sales revenues under a perpetual inventory system.

27. Recording Sales of Merchandise
Two Journal Entries to Record a Sale #1
Cash or Accounts receivable XXX
Selling Price
Sales XXX #2
Cost of goods sold XXX
Cost
Merchandise inventory XXX
SO 3 Explain the recording of sales revenues under a perpetual inventory system.

28. Recording Sales of Merchandise
Illustration: Assume PW Audio Supply records its May 4 sale of $3,800 to Sauk Stereo (Illustration 5-5) as follows. Assume the merchandise cost PW Audio Supply $2,400.
May 4
Accounts receivable 3,800
Sales 3,800 4
Cost of goods sold 2,400
Merchandise inventory 2,400
SO 3 Explain the recording of sales revenues under a perpetual inventory system.

29. Recording Sales of Merchandise
Sales Returns and Allowances
“Flipside” of purchase returns and allowances.
Contra-revenue account (debit).
Sales not reduced (debited) because:
would obscure importance of sales returns and allowances as a percentage of sales.
could distort comparisons between total sales in different accounting periods.
SO 3 Explain the recording of sales revenues under a perpetual inventory system.

30. Recording Sales of Merchandise
Illustration: Prepare the entry PW Audio Supply would make to record the credit for returned goods that had a $300 selling price (assume a $140 cost). Assume the goods were not defective.
May 8
Sales returns and allowances 300
Accounts receivable 300 8
Merchandise inventory 140
Cost of goods sold 140
SO 3 Explain the recording of sales revenues under a perpetual inventory system.

31. Recording Sales of Merchandise
Illustration: Assume the returned goods were defective and had a scrap value of $50, PW Audio would make the following entries:
May 8
Sales returns and allowances 300
Accounts receivable 300 8
Merchandise inventory 50
Cost of goods sold 50
SO 3 Explain the recording of sales revenues under a perpetual inventory system.

32. Recording Sales of Merchandise
Review Question
The cost of goods sold is determined and recorded each time a sale occurs in:
periodic inventory system only.
a perpetual inventory system only.
both a periodic and perpetual inventory system.
neither a periodic nor perpetual inventory system.
SO 3 Explain the recording of sales revenues under a perpetual inventory system.

33. Recording Sales of Merchandise
Sales Discount
Offered to customers to promote prompt payment.
“Flipside” of purchase discount.
Contra-revenue account (debit).
SO 3 Explain the recording of sales revenues under a perpetual inventory system.

34. Recording Sales of Merchandise
Illustration: Assume Sauk Stereo pays the balance due of $3,500 (gross invoice price of $3,800 less purchase returns and allowances of $300) on May 14, the last day of the discount period. Prepare the journal entry PW Audio Supply makes to record the receipt on May 14.
May 14
Cash 3,430 *
Sales discounts 70
Accounts receivable 3,500
* [($3,800 – $300) X 2%]
SO 3 Explain the recording of sales revenues under a perpetual inventory system.

35. Completing the Accounting Cycle
Adjusting Entries
Generally the same as a service company.
One additional adjustment to make the records agree with the actual inventory on hand.
Involves adjusting Merchandise Inventory and Cost of Goods Sold.
SO 4 Explain the steps in the accounting cycle for a merchandising company.

36. Completing the Accounting Cycle
Illustration: Suppose that PW Audio Supply has an unadjusted balance of $40,500 in Merchandise Inventory. Through a physical count, PW Audio determines that its actual merchandise inventory at year-end is $40,000. The company would make an adjusting entry as follows.
Cost of goods sold 500
Merchandise inventory 500
SO 4 Explain the steps in the accounting cycle for a merchandising company.

37. Completing the Accounting Cycle
Closing Entries
Dividends

38. Forms of Financial Statements
Multiple-Step Income Statement
Shows several steps in determining net income.
Two steps relate to principal operating activities.
Distinguishes between operating and non-operating activities.
SO 5 Distinguish between a multiple-step and a single-step income statement.

39. Multiple-Step Income Statement
Income Statement Presentation of Sales
Illustration 5-8
SO 5 Distinguish between a multiple-step and a single-step income statement.

40. Multiple-Step Income Statement
Gross Profit
Illustration 5-13
Key Items:
Net sales
Gross profit
Gross profit rate
Illustration 5-10
SO 6 Explain the computation and importance of gross profit.

41. Forms of Financial Statements
Illustration 5-13
Forms of Financial Statements
Multiple-Step
Key Items:
Net sales
Gross profit
Operating expenses
SO 5 Distinguish between a multiple-step and a single-step income statement.

42. Forms of Financial Statements
Illustration 5-13
Forms of Financial Statements
Key Items:
Net sales
Gross profit
Operating expenses
Nonoperating activities
Net income
SO 5 Distinguish between a multiple-step and a single-step income statement.

43. Forms of Financial Statements
Single-Step Income Statement
Subtract total expenses from total revenues
Two reasons for using the single-step format:
Company does not realize any type of profit until total revenues exceed total expenses.
Format is simpler and easier to read.
SO 5 Distinguish between a multiple-step and a single-step income statement.

44. Forms of Financial Statements
Illustration 5-14
Single-Step
SO 5 Distinguish between a multiple-step and a single-step income statement.

45. Forms of Financial Statements
Classified Balance Sheet
Illustration 5-15
SO 5 Distinguish between a multiple-step and a single-step income statement.

46. Periodic Inventory System
Periodic System
Separate accounts used to record purchases, freight costs, returns, and discounts.
Company does not maintain a running account of changes in inventory.
Ending inventory just counted “periodically” to see what is on hand and then COGS booked.
1 journal entry for sale -- COGS not recorded at Point of Sale (POS)
SO 7 Explain the recording of purchases and sales of inventory under a periodic inventory system.

47. Periodic Inventory System
Calculation of Cost of Goods Sold
Illustration 5A-1
$316,000
SO 7 Explain the recording of purchases and sales of inventory under a periodic inventory system.

48. Recording Purchases under Periodic System
Illustration: On the basis of the sales invoice (Illustration 5-5) and receipt of the merchandise ordered from PW Audio Supply, Sauk Stereo records the $3,800 purchase as follows.
May 4
Purchases 3,800
Accounts payable 3,800
SO 7 Explain the recording of purchases and sales of inventory under a periodic inventory system.

49. Recording Purchases under Periodic System
Freight Costs
Illustration: If Sauk pays Acme Freight Company $150
for freight charges on its purchase from PW Audio Supply on May 6, the entry on Sauk’s books is:
May 6
Freight-in (Transportation-in) 150
Cash
SO 7 Explain the recording of purchases and sales of inventory under a periodic inventory system.

50. Recording Purchases under Periodic System
Purchase Returns and Allowances
Illustration: Sauk Stereo returns $300 of goods to PW Audio Supply and prepares the following entry to recognize the return.
May 8
Accounts payable 300
Purchase returns and allowances 300
SO 7 Explain the recording of purchases and sales of inventory under a periodic inventory system.

51. Recording Purchases under Periodic System
Purchase Discounts
Illustration: On May 14 Sauk Stereo pays the balance due on account to PW Audio Supply, taking the 2% cash discount allowed by PW Audio for payment within 10 days. Sauk
Stereo records the payment and discount as follows.
May 14
Accounts payable 3,500
Purchase discounts 70
Cash 3,430
SO 7 Explain the recording of purchases and sales of inventory under a periodic inventory system.

52. Under a Periodic System
Sales Revenues -
Under a Periodic System
ONLY 1 entry is made for each sale
one to record sale

53. Recording Sales under Periodic System
Illustration: PW Audio Supply, records the sale of $3,800 of merchandise to Sauk Stereo on May 4 (sales invoice No. 731, Illustration 5-5) as follows.
May 4
Accounts receivable 3,800
Sales 3,800
No entry is recorded for cost of goods sold at the time of the sale under a periodic system.
SO 7 Explain the recording of purchases and sales of inventory under a periodic inventory system.

54. Recording Sales under Periodic System
Sales Returns and Allowances
Illustration: To record the returned goods received from Sauk Stereo on May 8, PW Audio Supply records the $300 sales return as follows.
May 4
Sales returns and allowances 300
Accounts receivable 300
SO 7 Explain the recording of purchases and sales of inventory under a periodic inventory system.

55. Recording Sales under Periodic System
Sales Discounts
Illustration: On May 14, PW Audio Supply receives payment of $3,430 on account from Sauk Stereo. PW Audio honors the 2% cash discount and records the payment of Sauk’s account receivable in full as follows.
May 14
Cash 3,430
Sales discounts 70
Accounts receivable 3,500
SO 7 Explain the recording of purchases and sales of inventory under a periodic inventory system.

56. Key difference between periodic and perpetual inventory…
is the point at which the costs of goods sold is computed.

57. Comparison of Entries-Perpetual vs. Periodic
Illustration 5A-2
SO 7 Explain the recording of purchases and sales of inventory under a periodic inventory system.

58. Comparison of Entries-Perpetual vs. Periodic
Illustration 5A-2
SO 7 Explain the recording of purchases and sales of inventory under a periodic inventory system.

59. Companies that use Periodic inventory take a physical count to...
determine ending inventory
compute cost of goods sold

60. Companies that use Perpetual inventory take a physical count to...
Check accuracy of “book inventory” to actual inventory.

61. Good Bye and Good Luck! End of Chapter 5
SO 5 Distinguish between a multiple-step and a single-step income statement.

62. Worksheet for a Merchandising Company
Illustration 5B-1
SO 8

63. Copyright
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66. Recording Purchases of Merchandise
Question
In a perpetual inventory system, a return of defective merchandise by a purchaser is recorded by crediting:
Purchases
Purchase Returns
Purchase Allowance
Merchandise Inventory
SO 2 Explain the recording of purchases under a perpetual inventory system.

67. Forms of Financial Statements
Review Question
The multiple-step income statement for a merchandiser shows each of the following features except:
gross profit.
cost of goods sold.
a sales revenue section.
investing activities section.
SO 5 Distinguish between a multiple-step and a single-step income statement.